In many markets, buy and sell orders at the same price are automatically matched. Thus, for example, a first order to buy an item at a price of 100 and a second order to sell the same item at a price of 100 will, in such markets, result in a transaction in which some quantity of the item is sold at the specified price. However, in some markets, for example, the secondary market for US Government treasuries, orders of equal price are not automatically matched. Rather, certain types of buy and sell orders, called “passive” orders, may co-exist at the same price without triggering a transaction. These passive orders do not trade unless “aggressed” against by a trader submitting a second type of order, called an “aggressive” order. Historically, a passive order to buy has been referred to as a “bid”, while a passive order to sell has been referred to as an “offer”. By contrast, an aggressive order to sell has been referred to as a “hit”, while an aggressive order to buy has been referred to as a “take” or “lift” depending on the market.
This distinction between passive and aggressive orders is one of several characteristics of the secondary market in US Government treasuries and other markets that has developed to encourage market liquidity. In particular, since it is impossible to generate liquidity in a market without having someone first make a price, inter-dealer brokers historically sought to encourage traders to submit bids and offers by not charging them a commission if their orders resulted in a trade. Thus, passive bids and offers could not be matched even at the same price since neither the passive buyer not the passive seller would be required to pay a commission and the inter-dealer broker would not execute a transaction without a commission being paid.
In addition to commission-free-trades, inter-dealer brokers in the secondary market for US Government treasuries and other markets also rewarded buyers and sellers by developing a number of trading protocols or conventions which granted certain buyers and sellers certain trading option or “rights”. One such convention is commonly referred to as “workup”. In general terms, this convention permits buyers and sellers to “work up” the size of a trade from the quantity traded as a result of an initial “hit” or “lift”. Historically, certain traders, including the first aggressive-side and passive-side traders, were granted an option or right to increase their size, and to trade that additional size ahead of other traders.
Conceptually, a workup is considered a single deal extended in time. This conception was reflected historically in several interesting aspects of workup trading. For example, because all trading during workup was considered part of a single deal, all such trading occurred at a single price point set by the initial hit or lift that triggered the workup. In addition, the initial aggressor's side of the market (i.e., the sell side in the case of a hit and the buy side in the case of a lift) was designated the “aggressive” side of the market for the duration of the workup. Similarly, the opposite side of the market was designated the “passive” side of the market for the entire workup. This designation played an important role in trading, including determining which entities would pay commission, historically paid only by the aggressive side of the market.
As electronic trading developed, electronic platforms were developed that provided for automated workup functionality. One such electronic platform is the BrokerTec® electronic trading platform operated by ICAP Electronic Broking which first included a workup functionality in May 2001. As originally launched, the BrokerTec® workup functionality included two distinct phases, a private phase and a public phase. During the private phase, an aggressor that bought or sold all displayed volume at the best available price was granted an exclusive right to trade additional volume for the duration of the private phase. If the aggressor failed to buy or sell all displayed volume at the best available price, no exclusive trading privileges were granted on the aggressive side of the market, and all traders on that side of the market traded on a first-come-first-served basis even during the private phase. On the passive side of the market, the first position bidder or offerer that was hit or lifted was granted exclusive trading privileges for the duration of the private phase.
The private phase in the BrokerTec electronic trading platform automatically expired after a fixed, non-extendable number of seconds tracked by a timer. Upon expiration of the private phase, the public phase commenced. During the public phase, all trading on both sides of the market was conducted on a first-come-first-served basis. The duration of the public phase was also controlled by a timer. But unlike the private-phase timer, the public-phase timer was reset each time a new execution occurred during the workup. Thus, expiration of the public-phase timer indicated a sustained period of trading inactivity and caused the system to end the workup.
The BrokerTec electronic trading platform includes four types of aggressive orders: fill or kill (FoK), fill and store (FaS), fill and kill (FaK) and fill and kill immediate (FaKi): Generally speaking, a FoK order is executed only if it can be completely filled. Thus, for example, if a trader submits a FoK order to buy 10 mm of a particular security at par and only 8 mm of that security is available at that price, no trade occurs and the order is “killed” i.e., not entered in the order book.
By contrast, FaK, FaKi and FaS orders may be partially filled. When a FaS order is partially filled, the unfilled portion of the order is automatically converted to a new order for the unfilled size on what is called the “follow,” i.e., the period following completion of the trade. Thus, if a trader submits a FaS order to buy 10 mm of a particular security at par and only 8 mm of that security is available at that price, 8 mm of the order is filled, and the unfilled portion of the order is converted into a new passive order to buy 2 mm of the specified security at par at the end of workup.
When a FaK order is partially filled, the unfilled portion of the order is “killed” and does not result in an order for the unfilled size on the follow. Thus, if a trader submits a FaK order to buy 10 mm of a particular security at par and only 8 mm of that security is available at the price, 8 mm of the order is filled, and the order's unfilled portion is “killed” at the end of the workup. FaKi orders are traded to the maximum extent possible at the time of entry and the rest is cancelled immediately. By contrast, any portion of a FaK order that cannot be immediately traded when entered is stored and may be traded during the duration of a workup and any size remaining at the end of the workup is killed. FaKi orders may only be submitted by automated or algorithmic trading terminals.
More recently, the BrokerTec system has been modified to incorporate a variation of workup which has no private phase but two public phases, one occurring after the other. This protocol is described in commonly assigned co-pending application U.S. Ser. No. 11/475,975, the contents of which are incorporated herein by reference in their entirety for all purposes including without limitation with respect to the trading rules applied during workup. This variation of workup is known as double public as it consists of two public phases.
In the double public protocol, a first workup period commences when a trade between two parties is executed. In contrast to the previous private workup, this workup period is open to any trader on the system, in addition to the parties that commenced the workup, to submit additional orders for the item transacted. These additional orders are transacted at the same price as the original transaction. The first phase of workup lasts either for a predetermined time, typically in the order of 3 or 4 seconds, or until an additional transaction takes place, in which case the protocol moves to a second phase in which any party can still submit additional orders to trade at the same price as the original transaction, which is the price of the original matched passive order. This is again a public workup, but on commencement, a timer is started and, after a predetermined period, typically shorter than the first workup period, the timer expires and the workup finishes. However, in contrast to the first workup period, the timer is reset every time an additional trade is executed. In this way, the workup lasts as long as there is interest in the market to conduct trades at the price of the original matched transaction. But the workup ends when that interest ends, so allowing the market to move to the next price point without delay.
It will be appreciated that the double public workup does not provide any trader exclusive privileges to the parties to the original transaction. The original rationale for providing these privileges was to encourage market making that is the submission of passive orders into the market to provide liquidity. It has been found that this encouragement is not equally important in all markets. This is particularly true in markets where a significant amount of trading activity is conducted by algorithmic traders. Algorithmic traders are computers that act as automated trading interfaces which make trading decisions and execute orders on the basis of a trading algorithm which responds in a predetermined manner to changes in market conditions. Algorithmic traders will submit orders, either passively or aggressively in response to their programming and do not need the encouragement provided by private workup.
The secondary market in US Government treasuries is a good example of a market in which algorithmic traders are very active. We have appreciated that it is desirable to improve the double public workup protocol as, in its original form it is not capable of reacting rapidly enough to meet the demands of algorithmic traders in particular when the market is unwilling to transact further at the price point of the transaction that triggered the workup.
This need arises largely due to the speed at which algorithmic traders react. As they are computers, algorithmic traders react near instantaneously to changing market data; much quicker than traditional human traders. Accordingly, if algorithmic traders do not want to transact workup trades, the fixed phase of the first public workup period is a comparatively long time for them to wait until they can submit further orders. From the point of view of the system operator, this is a period during which potential deals are lost, and so potential revenue through commission is lost.